Category Archives: growth

Last December we wrote “we finally have more than just hope to believe that this year, 2017, is the year the Plow Horse Economy finally gets a spring in its step.” We expected real GDP growth to accelerate from 2.0% in 2016 to “about 2.6%” in 2017. Our optimism was, in large part, based on our belief that the incoming Trump Administration would wield a lighter regulatory touch and move toward lower tax rates.

So far, so good. Right now, we’re tracking fourth quarter real GDP growth at a 3.0% annual rate, which would mean 2.7% growth for 2017 and we expect some more acceleration in 2018.

The only question is: how much? Yes, a major corporate tax cut (which should have happened 20 years ago) is finally taking place. And, yes, the Trump Administration is cutting regulation. But, it has not reigned in government spending. As a result, we’re forecasting real GDP growth at a 3.0% rate in 2018, the fastest annual growth since 2005.

The only caveat to this forecast is that it seems as if the velocity of money is picking up. With $2 trillion of excess reserves in the banking system, the risk is highly tilted toward an upside surprise for growth, with little risk to the downside. Meanwhile, this easy monetary policy suggests inflation should pick up, as well. The consumer price index should be up about 2.5% in 2018, which would be the largest increase since 2011.

Unemployment already surprised to the downside in 2017. We forecast 4.4%; instead, it’s already dropped to 4.1% and looks poised to move even lower in the year ahead. Our best guess is that the jobless rate falls to 3.7%, which would be the lowest unemployment rate since the late 1960s.

A year ago, we expected the Fed to finally deliver multiple rate hikes in 2017. It did, and we expect that pattern will continue in 2018, with the Fed signaling three rate hikes and delivering at least that number, maybe four. Longer-term interest rates are heading up as well. Look for the 10-year Treasury yield to finish 2018 at 3.00%.

For the stock market, get ready for a continued bull market in 2018. Stocks will probably not climb as much as this year, and a correction is always possible, but we think investors would be wise to stay invested in equities throughout the year.

We use a Capitalized Profits Model (the government’s measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks. Our traditional measure, using a current 10-year Treasury yield of 2.35% suggests the S&P 500 is still massively undervalued.

If we use our 2018 forecast of 3.0% for the 10-year yield, the model says fair value for the S&P 500 is 3351, which is 25% higher than Friday’s close. The model needs a 10-year yield of about 3.75% to conclude that the S&P 500 is already at fair value, with current profits.

Yes, this is optimistic, but a year ago we were forecasting the Dow would finish this year at 23,750 with the S&P 500 at 2,700. This was a much more bullish call than anyone else we’ve seen, but we stuck with the fundamentals over the relatively pessimistic calls of “conventional wisdom,” and we believe the same course is warranted for 2018. Those who have faith in free markets should continue to be richly rewarded in the year ahead.

The Federal Reserve has a problem. At 4.1%, the jobless rate is already well below the 4.6% it thinks unemployment would/could/should average over the long run. We think the unemployment rate should get to 3.5% by the end of 2019 and wouldn’t be shocked if it got that low in 2018, either.

Add in extra economic growth from tax cuts and the Fed will be worried that it is “behind the curve.” As a result, we think the Fed will raise rates three times next year, on top of this year’s three rate hikes, counting the almost certain hike this month. And a fourth rate hike in 2018 is still certainly on the table. By contrast, the futures market is only pricing in one or two rate hikes next year – exactly as it did for 2017. In other words, the futures markets are likely to be wrong for the second year in a row.

And as short-term interest rates head higher, we expect long-term interest rates to head up as well. So, get ready, because the bears will seize on this rising rate environment as one more reason for the bull market in stocks to end.

They’ll be wrong again. The bull market, and the US economy, have further to run. Rising rates won’t kill the recovery or bull market anytime in the near future.

Higher interest rates reflect a higher after-tax return to capital, a natural result of cutting taxes on corporate investment via a lower tax rate on corporate profits as well as shifting to full expensing of equipment and away from depreciation for tax purposes.

Lower taxes on capital means business will more aggressively pursue investment opportunities, helping boost economic growth and the demand for labor – leading to more jobs and higher wages. Stronger growth means higher rates.

For a recent example of why higher rates don’t mean the end of the bull market in stocks look no further than 2013. Economic growth accelerated that year, with real GDP growing 2.7% versus 1.3% the year before. Meanwhile, the yield on the 10-year Treasury Note jumped to 3.04% from 1.78%. And during that year the S&P 500 jumped 29.6%, the best calendar year performance since 1997.

This was not a fluke. The 10-year yield rose in 2003 and 2006, by 44 and 32 basis points, respectively. How did the S&P 500 do those years: up 26.4% in 2003, up 13.8% in 2006.

Sure, in theory, if interest rates climb to reflect the risk of rising inflation, without any corresponding increase in real GDP growth, then higher interest rates would not be a good sign for equities. That’d be like the late 1960s through the early 1980s. But with Congress and the president likely to soon agree to major pro-growth changes in the tax code on top of an ongoing shift toward deregulation, we think the growth trend is positive, not negative.

It’s also true that interest on the national debt will rise as well. But federal interest costs relative to both GDP and tax revenue are still hovering near the lowest levels of the past fifty years. As we’ve argued, sensible debt financing that locks in today’s low rates would be prudent. However, it will take many years for higher interest rates to lift the cost of borrowing needed to finance the government back to the levels we saw for much of the 1980s and 1990s. And as we all remember the 80s and 90s were not bad for stocks.

Bottom line: interest rates across the yield curve are headed higher. But, for stocks, it’s just another wall of worry not a signal that the bull market is anywhere near an end.

The MSCI Emerging Markets Index, up 28.09%, is the best performing major index year-to-date – better than the DASDAQ, better than the S&P 500, better than the DJIA. That’s an amazing reversal.

Emerging Markets have lagged the other major indexes over the last decade.

2.21% for 3 years (vs. 9.57% for the S&P 500)

5.56% for 5 years (vs. 14.36% for the S&P 500)

2.76% for 10 years (vs. 7.61% for the S&P 500)

Why do we mention this? A well diversified portfolio often includes an allocation to Emerging Markets. Emerging Markets represent the economies of countries that have grown more rapidly than mature economies like the US and Europe.

Countries in the index include Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, and the United Arab Emirates. Some of these countries have economic problems but economic growth in countries like India, China, and Mexico are higher than in the U.S.

Between 2003 and 2007 Emerging Markets grew 375% while the S&P 500 only advanced 85%. As a result of the economic crisis of 2008, Emerging Markets suffered major losses. It is possible that these economies may now have moved past that economic shock and may be poised to resume the kind of growth that they have exhibited in the past. Portfolios that include an allocation to Emerging Markets can benefit from this recovery.

I recently heard about a 62-year-old who was scared out of the market following the dot.com crash in 2000. For the last 17 years his money has been in cash and CDs, earning a fraction of one percent. Now, with the market reaching record highs, he wants to know if this is the right time to get back in. Should he invest now or is it too late?

Here is what one advisor told him:

My first piece of advice to you is to fundamentally think about investing differently. Right now, it appears to me that you think of investing in terms of what you experience over a short period of time, say a few years. But investing is not about what returns we can generate in one, three, or even 10 years. It’s about what results we generate over 20+ years. What happens to your money within that 20-year period is sometimes exalting and sometimes downright scary. But frankly, that’s what investing is.

Real investing is about the long term, anything else is speculating. If we constantly try to buy when the market is going up and going to cash when it goes down we playing a loser’s game. It’s the classic mistake that people make. It’s the reason that the average investor in a mutual fund does not get the same return as the fund does. It leads to buying high and selling low. No one can time the market consistently. The only way to win is to stay the course.

But staying the course is psychologically difficult. Emotions take over when we see our investments decline in value. To avoid having our emotions control our actions we need a well-thought-out plan. Knowing from the start that we can’t predict the short-term future, we need to know how much risk we are willing to take and stick to it. Amateur investors generally lack the tools to do this properly. This is where the real value is in working with a professional investment manager.

The most successful investors, in my view, are the ones who determine to establish a long-term plan and stick to it, through good times and bad. That means enduring down cycles like the dot com bust and the 2008 financial crisis, where you can sometimes see your portfolio decline. But, it also means being invested during the recoveries, which have occurred in every instance! It means participating in the over 250%+ gains the S&P 500 has experience since the end of the financial crisis in March 2009.

The answer to the question raised by the person who has been in cash since 2000 is to meet with a Registered Investment Advisor (RIA). This is a fiduciary who is obligated to will evaluate his situation, his needs, his goals and his risk tolerance. And RIA is someone who can prepare a financial plan that the client can agree to; one that he can follow into retirement and beyond. By taking this step the investor will remove his emotions, fears and gut instincts from interfering with his financial future.

The election has created tectonic shifts in government and promises to make bold changes in the economy. We have been gathering consensus views from some leading financial analysts for 2017

Global interest rates are going up.

Global inflation is going up.

Global growth is going up.

Recession risk is going down.

A new consensus is also building. The rise of nationalistic self-interest is upsetting the old order the world over. For the past decade central bankers have been in control of economic policy throughout the world. It has resulted in low or even negative interest rates in an effort to stimulate economic growth. The result has been like pushing on a string. Growth has been slow (the string as a whole hasn’t been moving) and the middle class in the developed world has seen their wages stagnate and their jobs disappear (the middle of the string) while those at the top (the far end of the string) have been virtually unaffected. It’s part of the reason for the change in political leadership in the U.S. and the re-emergence of economic nationalism as evidenced by the Brexit vote in Britain.

As central bank leadership takes a back seat to aggressive fiscal policy, we can expect political leadership to focus on job growth and economic relief for the long-neglected middle class. Domestically, here is what we expect to see:

Tax reform: Trump’s campaign promised corporate tax reform. To make American companies more competitive globally, he has proposed reducing corporate tax rates from 35% to 15%. A special 10% rate is designed to repatriate corporate profits held offshore.

Individuals will be taxed at three rates depending on income: 12%, 25% and 33%.

Trade: The new administration has vowed to withdraw from TPP (Trans Pacific Partnership) and renegotiate NAFTA (North American Free Trade Agreement). They also intend to challenge China regarding currency manipulation and unfair trade practices.

Economy: 25 million new jobs over the next decade is the goal of the incoming administration. They aim to boost economic growth from 1.5% to 3.5% or 4.0% annually.

The Trump administration will focus on job creation, economic growth, infrastructure spending, reduced regulation, and energy independence while reducing governmental efforts to prevent climate change. The people that Donald Trump has chosen for his cabinet are largely from the private sector; people that have backgrounds in running successful businesses and creating jobs.

These things are the primary reason that the stock market has reacted well to the election of Donald Trump. Corporate earnings have been essentially flat for the past three years. Professional investors see opportunities for renewed economic growth, which will increase corporate profits. While we view this development with optimism, we always remain cautious. We expect increased market volatility, especially if terrorist attacks continue throughout the globe. We also expect interest rates to rise as the Federal Reserve brings rates to a more historically normal level.

We also see opportunities for the creation of new companies. The number of publicly traded companies has dropped by nearly 50% since 2000. At the same time, the number of companies that are held by private equity firms has grown explosively – by a factor of six! This provides a great opportunity for privately held companies to go public and provide yet another opportunity for greater market growth.

As always, we remain cautious in keeping with our philosophy of preserving our clients’ capital. Over the long term, we see the potential for a new American renaissance.

We have been talking about the “Plow Horse Economy” for quite a while now. Low interest rates designed to spur economic growth have been offset by other government policies that have acted as a “Plow” holding the economy back.

Market watchers have assumed that the November election would see a continuation of those policies. The general prediction was for slow growth, falling corporate profits, a possible deflationary spiral, and flat yield curves.

What a difference a week makes. The market shocked political prognosticators by standing those expectations on their heads.

Bank of America surveyed 177 fund managers in the week following the elections who say they’re putting cash to work this month at the fastest pace since August 2009.

The U.S. election result is “seen as unambiguously positive for nominal GDP,” writes Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett, in a note accompanying the monthly survey.

The stock market has reached several new all-time highs, moving the DJIA to a record 18,924 on November 15th, up 3.6% in one week.

Interest rates on the benchmark 10-year US Treasury bond have risen from 1.83% on November 7th to 2.25% today (November 17th), a 23% increase. Expectations for the yield curve to steepen — in other words, for the gap between short and long-term rates to widen — saw their biggest monthly jump on record.

WealthManagement.com says that

Global growth and inflation expectations are also tracking the ascent of Trump. The net share of fund managers expecting a stronger economy nearly doubled from last month’s reading, while those surveyed are the most bullish on the prospect of a pick-up in inflation since June 2004.

Investors are now also more optimistic about profit growth than they have been in 15 months.

Whether this new-found optimism is justified is something that only time will tell. In the meantime to US market is reacting well to Trump’s plans for tax cuts and infrastructure spending. Spending on roads, bridges and other parts of the infrastructure has been part of Trump’s platform since he entered the race for President. It’s the tax reform that could be the key to a new economic stimulus.

According to CNBC American corporations are holding $2.5 trillion dollars in cash overseas. That’s equal to 14% of the US gross domestic product. If companies bring that back to the US it would be taxed at the current corporate tax rate of 35%. The US has the highest corporate tax rate in the world. The promise of lower corporate tax rates – Trump has spoken of 15% – could spur the repatriation of that cash to the US, giving a big boost to a slow growth US economy.

Defining how much risk someone is willing to take can be difficult. But in the investment world it’s critical.

Fear of risk keeps a lot of people away from investing their money, leaving them at the mercy of the banks and the people at the Federal Reserve. The Fed has kept interest rates near zero for years, hoping that low rates will cause a rebound in the economy. The downside of this policy is that traditional savings methods (saving accounts, CDs, buy & hold Treasuries) yield almost no growth.

Investors who are unsure of their risk tolerance and those who completely misjudge it are never quite sure if they are properly invested. Fearing losses, they may put too much of their funds into “safe” investments, passing up chances to grow their money at more reasonable rates. Then, fearing that they’ll miss all the upside potential, they get back into more “risky” investments and wind up investing too aggressively. Then when the markets pull back, they end up pulling the plug, selling at market bottoms, locking in horrible losses, and sitting out the next market recovery until the market “feels safe” again to reinvest near the top and repeating the cycle.

There is a new tool available that help people define their personal “risk number.”

What is your risk number?

Your risk number defines how much risk you are prepared to take by walking you through several market scenarios, asking you to select which scenarios you are more comfortable with. Let’s say that you have a $100,000 portfolio and in one scenario it could decline to $80,000 in a Bear Market or grow to $130,000 in a Bull Market, in another scenario it could decline to $70,000 or grow to $140,000, and in the third scenario it could decline to $90,000 or grow to $110,000. Based on your responses, to the various scenarios, the system will generate your risk number.

How can you use that information?

If you are already an investor, you can determine whether you are taking an appropriate level of risk in your portfolio. If the risk in your portfolio is much greater than your risk number, you can adjust your portfolio to become more conservative. On the other hand, if you are more risk tolerant and you find that your portfolio is invested too conservatively, you can make adjustments to become less conservative.

One of our favorite market analysts, Brian Wesbury – who coined the term “Plow horse Economy” to describe the current economic situation – has been accused of being a “perma-bull” because he had discounted all the predictions of recession over the last 7 1/2 years. We can understand why people are concerned about recessions because 2008 is still fresh in our minds. The recovery that began in 2009 has been anemic. Millions of people have not seen their financial situation improve.

Remember fears about adjustable-rate mortgage re-sets, or the looming wave of foreclosures that would lead to a double-dip recession? Remember the threat of widespread defaults on municipal debt? Remember the hyperinflation that was supposed to come from Quantitative Easing? Or how about the Fiscal Cliff, Sequester, or the federal government shutdown? Or the recession we were supposed to get from higher oil prices…and then from lower oil prices? How about the recession from the looming breakup of the Euro or Grexit or Brexit?

None of these things has brought on the oft-predicted recession. Wesbury says that at some point a recession will come. We have not reached the point where fiscal or economic policy has eliminated that possibility. He mentions several indicators, including truck sales and “core” industrial production as indicators that should be watched.

Meanwhile,

Job growth continues at a healthy clip. Initial unemployment claims have averaged 261,000 over the past four weeks and have been below 300,000 for 80 straight weeks. Consumer debt payments are an unusually low share of income and consumers’ seriously delinquent debts are still dropping. Wages are accelerating. Home building has risen the past few years even as the homeownership rate has declined, making room for plenty of growth in the years ahead.

Meanwhile, there haven’t been any huge shifts in government policy in the past two years. Yes, policy could be much better, but the pace of bad policies hasn’t shifted into overdrive lately.

In other words, our forecast remains as it has been the past several years, for more Plow Horse economic growth. But you should never have any doubt that we are constantly on the lookout for something that can change our minds.

While the next recession may or may not be right around the corner, serious investors should be prepared for the eventuality so that when it does arrive, they will be ready. We invite your inquiries.

Albert Einstein is credited with saying “compound interest is the eighth wonder of the world.”

To get back to the original question, would you prefer to have $1 million today or one cent that will double every day for 30 days? If you chose the million dollars, you would leave millions on the table.

If you chose the penny and passed up the million dollars, on the second day your penny would be worth two cents, on day three it would be four cents, on the fourth day it would be 8 cents. By day 18 the penny will have grown to $1,310.72. By day 28 it will be worth over a million dollars: $1,342,177. On the 30th day it would be worth an astounding $5,368,709!

If the penny were to be allowed to double for another 30 days, the penny would grow to over $5 quadrillion (five thousand trillion!) dollars.

One of the things this illustrates is that compound growth takes time to make a dramatic difference. For the person who wants to have enough money to retire in comfort, starting early is the key to success, even if the starting amount is small.

We have all heard Aesop’s Fable about the race between the tortoise and the hare. The hare, convinced that he was much faster than the tortoise, took time out for a meal and a nap. When he woke up he realized his mistake but the tortoise crossed the finish line first.

It seems that this fable is especially true about how people grow rich when investing. There are some spectacularly wealth people who got that way virtually over night – we have all read about them – but the vast majority of the “High Net Worth” (HNW) people – those with at least $3 million in investable assets – did it the tortoise way.

The interesting thing about these HNW people is that they rose from the poor and the middle class; they did not inherit their wealth.

A study by Bank of America and U.S. Trust found that 77% – more than three quarters – of their clients grew their wealth slowly. 83% said that they grew rich by making small wins rather than taking large risks. They grew their wealth by careful investing and avoiding major losses.

In our practice we have met quite a few people who managed to turn modest incomes into multi-million dollar portfolios. We have also spoken with people who took big investment risks only to fail, and have to continue to work long after they planned to retire.

It’s up to each one of us to decide what race we wish to run. But keep in mind that the odds favor the tortoise over the hare. And if you have a problem with the slow-but-steady approach to wealth, get a good RIA who will guide you.